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Use lots of independent contractors? Heed new legal risks

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in Compensation and Benefits,Employee Benefits Program,Employment Law,Human Resources

Same work, fewer expenses and less hassle.

That’s the perceived advantage of using independent contractors. And the mantra has its appeal. But many employers have opted for freelancers only to find a new set of problems: lack of control, unreliable workers and, in some cases, litigation.

In the worst-case scenario, a court or government agency will force you to reclassify those workers from independent contractors to employees. That can mean you’ll owe thousands in back wages, overtime payments, employers’ share of Social Security taxes and workers’ comp benefits.

That’s why employers who use independent contractors must structure their contracts—and treat those workers—very carefully to comply with IRS and Labor Department rules. Each agency sets different rules about what type of workers are considered “employees” and “independent contractor.” Plus, labor unions are now shaking the trees of employers who use lots of independent-contract labor.

IRS is always suspicious

The IRS estimates that 80 percent of workers classified as independent contractors don’t meet the test and should actually be employees. That means that if the IRS comes calling, they’re already predisposed to reclassify your independent contractors.

Generally, the more control you exert over how, when and where a person’s work is done, the more likely that person should be declared a full-fledged employee, not an independent contractor.

The IRS currently looks at these three main issues when making the employee/independent contractor decision:

  1. Do you have behavioral control over the worker?
  2. Do you exert financial control over the worker?
  3. What type of relationship exists between the worker and employer?

Expect the IRS to look at contracts, payment methods, whether your independent contractors have specialized training, whether they have other clients and how they run their business. 

Labor Department gets active

The Labor Department has begun aggressively enforcing its notion of what constitutes an employee. In early 2006, it filed an FLSA lawsuit against California-based Janitorial Carpet Maintenance, alleging the company avoided paying minimum wage and overtime by misclassifying its janitors as independent contractors.

The company also used unpaid “helpers” to do the work.

The Labor Department has a relatively simple and broad definition of employment: Whenever you “suffer or permit” someone to work, the agency presumes an employer/employee relationship.

Again, the more control you exert over when, how, how much and how fast the work is done, the more likely Labor officials will treat your independent contractors as employees.

New union threat

Not only do you need to worry about government agencies and employees claiming misclassification, you now have unions to fret about.

The Teamsters recently began an organizing push targeted at Federal Express, arguing that the company’s use of independent contractors is a sham to pass costs onto employees and to prevent drivers from organizing into a union. FedEx claims its drivers are true independent contractors and, therefore, they have no right to unionize.

Advice: If you employ lots of independent contractors, take note of the FedEx case, and not just because of the potential union-organizing risk. Drivers themselves are suing the company, claiming FLSA violations and asking for class-action status.

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